Mr. Pink. I have to go out for a while and want to shortcut this thing. So, thought you might enjoy a couple of excerpts form the latest Morgan Stanley report on IDT dated June 16, 1999
Morgan Stanley certainly doesn't agree with your thinking at all
4 MORGAN STANLEY DEAN WITTER
Current Market Cap $663,098 Core business multiples Impl ied Valuation of Core Business Current Implied Multiple of Net2Phone revenues Implied Valuation of IDT Share of Net2Phone
Calendar 1999E core revenues $772,157 0.9X $694,941 (0.7X) ($31,843)
Calendar 2000E core revenues $877,354 0.7X $579,054 1.3X $84,044
There is concern among investors that Internet telephony will face difficulty as a stand-alone, sustainable business model. We note, however, that IDT has taken its model of Internet telephony further than most of its competitors, working with portals and software suppliers to make its applications as ubiquitous as possible. We would suggest, then, that viewing Net2Phone as a liability – as this valuation clearly does – takes even the most bearish outlook on Internet telephony too far. We also believe that the high end of the implied valuation range falls short of recognizing Net2Phone's leading position in the Internet telephony market. We note that Destia (Strong Buy, $11.88), the competitive international carrier with the highest retail exposure in the group, is trading at just under 2.0X calendar 1999E revenues and that it is just beginning to exploit the potential of its e-commerce business. We thus believe that a range of 5.0X to 10.0X forward revenues is a reasonable approximation of what the Net2Phone offering will bring, reflecting the high growth rates associated with the Internet, but still well below what the higher-valued pure-play Internet providers are trading at. The bottom line we draw from this approach is that the market is currently undervaluing the upside potential to be realized from the Net2Phone offering.
Raising Target Price
How great is the upside potential? Using the valuation framework outlined above, we arrive at a valuation range of $922 million to $1.2 billion for IDT after the Net2Phone offering, taking into account the reduction in IDT's ownership. This translates into a per-share value range of $25.20 to $32.00, representing upside of 49% to 87% in IDT stock.
Current Share Price IDT Valuation Using Offering Multiple Per Share Upside Offering Multiple of Calendar Year Revenues Value of IDT Share of NTOP at Multiple
$18.13 $988,387 $27.02 49.1% 5.0X $107,171
$18.13 $1,021,186 $27.91 54.0% 5.0X $166,461
$18.13 $1,145,558 $31.31 72.8% 10.0X $264,342
$18.13 $1,237,647 $33.83 86.6% 10.0X $382,922
As always, we look to our conservative discounted cash flow analysis to provide a check on multiples valuation. Our DCF in this instance confirms what the comps tell us, in this case pointing to a midpoint value of about $29 per share. We note that the DCF uses a cost of equity of 17%, very high for an EPS-positive firm such as IDT, and a below-market P/E midpoint of 22X. We believe, though, that these parameters serve to capture some of the fundamental concerns investors have about the sector.
In summary, we believe that our analysis points toward a real undervaluation of IDT stock. Despite the degree of uncertainty surrounding the pricing of the Net2Phone offering, we believe that the conservative approach we have taken highlights upside in IDT's stock given what are, in our view, reasonable assumptions derived from market valuations of other Internet-oriented offerings.
Here's more"
The company attributed the majority of the revenue surprise to opportunities it exploited in its wholesale business. While we regard positively IDT's ability to move quickly in this area, these results reverse the trend toward decreasing wholesale revenues as a percentage of IDT's overall business mix. We believe that the results also raise the question of whether they raise too high a bar for revenue growth going forward. We do note, however, that our estimates called for very slow growth in the quarter – just over 3% on a sequential quarter over quarter basis – and that the 19.3% rate IDT turned in for fiscal 3Q1999 was actually slightly lower than the 20.6% pace the company set in fiscal 2Q1999.
Adjusting Estimates
Accordingly, we have adjusted our fiscal 4Q1999E revenue estimates to reflect an 8.2% sequential quarter over quarter growth rate off of the strong performance for fiscal 3Q1999. Given the fluid nature of the wholesale business, we will work closely with IDT management as fiscal 4Q1999 progresses to gain better visibility on the state of this side of the company's operations.
Net2Phone Valuation Implications
Since the announcement of the proposed spin-off of Net2Phone, its Internet telephony subsidiary, IDT's stock price has fallen off as much as 43% from its highs in April. Given that much of the price rise could be attributed to enthusiasm surrounding the spin-off, the scenario is confusing. In an effort to gain some clarity into the stock's valuation, we have taken a rough cut at valuation of IDT as a whole, using some general indications of the size of the impending offering from company management.
We approached the question from two perspectives. First, we used a range of revenue multiples relative to our forecast of Net2Phone's calendar 1999E and 2000E sales ($47.6 million and $65.6 million, respectively, in our model) and then looked at the valuation implied for IDT's core operations. Second, we applied current trading multiples to IDT's core business and checked the implied valuation of Net2Phone. We factored in IDT's current 66.6% ownership of Net2Phone following the equity investments by SoftBank, AOL, GE Capital and others. We also assumed an offering size of $50 million, with our range of valuations implying greater or lesser IDT post-offering stakes in Net2Phone. In all of our calculations, we used market capitalization for the numerator in our multiples, given IDT's and Net2Phone's negligible net debt status.
Given the first-to-market nature of the Net2Phone spin-off – there are currently no pure-play Internet telephony service companies – we, along with the rest of the market, are waiting with interest to see the eventual pricing of the Net2Phone offering. We believe the range is bounded at the low end by an ILD retail revenue, and at the top by the valuations of “dot com” Internet companies. This valuation ceiling in itself implies a wide range, however, and this uncertainty is exacerbated by the lack of clear-cut comps within this group for Net2Phone. It would seem reasonable, though, given Net2Phone's market position as a leading “click to talk” provider with a presence on a number of portals, and significant strategic and financial backers such as SoftBank and GE Capital, that the current implied multiples will prove to be below the eventual pricing of the offering, as we will illustrate.
We used a range of 2X to 10X calendar 1999E and 2000E revenues to estimate a value for Net2Phone. While this range is wide, we believe it reflects a conservative take on valuations for Internet-associated offerings, and reflects the uncertainty around the Internet telephony space in general, as we discuss further below.
Given this range, we arrive at a valuation for Net2Phone of from just under $100 million at 2X calendar 1999E revenues to about $650 million at 10X 2000E revenues.
Net2Phone Valuation Matrix
Multiple 2X 5X 10X
Calendar 1999E Net2Phone revenues $47,628 $95,255 $238,138 $476,276
Calendar 2000E Net2Phone revenues $65,594 $131,189 $327,971 $655,943 |
